Quamet MSC530M G02 3T 2020-2021

Game 1 Part IV. Problem solving

1. Forecasting – 30pts

Data below shows the stock index for the period 1-10. It also shows the closing price
of Stocks A & B for the same period.

Stock
Period Index Stock A Stock B
13,66
1 8 55.5 37.4
13,65
2 0 55.2 36.7
13,68
3 6 51.5 36.9
14,17
4 9 56.3 41.7
14,58
5 1 56.5 43.7
14,72
6 2 53.1 44.5
15,12
7 2 54.7 48.3
14,76
8 9 55.3 44.4
14,85
9 4 54.1 45.1
15,56
10 3 54.9 47.1

1.1 Forecast stock index for period 11 using the following approaches. Interpret
fully the results for each computation.
a. Moving average base 2 and base 3; 3pts

0.5pts for the forecast result and the graph outputs

The 11th period forecast for stock index (SI) in moving average (MA) base 2 is 15,206 with a
standard error (SE) value of 519. The graph of the forecast is on the right. 1pt for
interpretation

0.5pts for the forecast result and the graph outputs

The 11th period forecast for SI in MA3 is 15,062 with a SE value of 625. The graph of the
forecast is on the right. MA2 provides better forecast since its SE is lower vs. MA3. 1pt for
interpretation

b. Simple exponential smoothing (SES) with alpha = 0.3 and 0.7; 3pts

0.5pts for the forecast result and the graph outputs

The 11th period forecast for SI in SES alpha =0.3 is 15,062 with a SE value of 625. The graph
of the forecast is on the right. 1pt for interpretation

0.5pts for the forecast result and the graph outputs

The 11th period forecast for SI in SES alpha =0.7 is 15,348 with a SE value of 455. The graph
of the forecast is on the right. SES alpha=0.7 provides better forecast since its SE is lower vs.
SES alpha = 0.3. 1pt for interpretation

c. Time series regression. 3pts

0.5pts for the forecast result and the graph outputs

SI increases by an average of 205 as you increase time by 1 period. 0.5pt

The r-value shows a very strong linear relationship between SI and time. 0.5pt
The Pearson test for significance with df=8 shows critical value =0.632. Since the r-value
false outside the -0.632 to 0.632 range, there is significant linear relationship between SI and
time. 0.5pt
With the r-squared value, 88% of the changes in SI can be explained by time. Only 12% is
accounted for by other variables. 0.5pt
The linear trend forecast for the 11th period = 15,608 with an SE = 242. The graph of the
forecast is on the right. 0.5pt

d. Which of the five approaches will provide the best forecast? Justify your
answer. 1pt

Best approach is linear trend model since it has the lowest SE =242 compared to the 4 other
methods. In addition, the r and r-squared values show significant results as seen from the
above discussions.
 1.2 Develop a regression model to predict the price of Stock A based on the Stock
Index. Interpret fully the results of your computations. 5pts

0.5pts for the forecast result and the graph outputs

Stock A increases by an average of 0.00024 as you increase SI by 1 unit. 0.75pt

The SE of the model = 1.58. 0.5pt
The r-value shows a very weak linear relationship between Stock A and SI. 0.5pt
The Pearson test for significance with df=8 shows critical value =0.632. Since the r-value
false within the -0.632 to 0.632 range, there is no significant linear relationship between
Stock A and SI. 1pt
With the r-squared value, only 1.1% of the changes in Stock A can be explained by SI. 99%
is accounted for by other variables. 0.75pt
The Anova result with critical p=0.05 < computed p=0.76 show that Stock A is not related to
SI, consistent with the Pearson test. 1pt

1.3 Develop a regression model to predict the price of Stock B based on the Stock
Index. Interpret fully the results of your computations. 5pts

Stock B increases by an average of 0.006 as you increase SI by 1 unit. 0.75pt

The SE of the model = 1.14. 0.5pt
The r-value shows a very strong linear relationship between Stock B and SI. 0.5pt
The Pearson test for significance with df=8 shows critical value =0.632. Since the r-value
false outside the -0.632 to 0.632 range, there is a significant linear relationship between Stock
B and SI. 1pt
With the r-squared value, only 93% of the changes in Stock B can be explained by SI. Only
7% is accounted for by other variables. 0.75pt
The Anova result with critical p=0.01 > computed p=0.000005 shows that Stock B is
significantly related to SI, consistent with the Pearson test. 1pt

1.4 Which of the two stocks’ performance is explained better by the Stock Index.
Cite reasons for your answer. 2pts

Stock B. Stronger r-value with significant Pearson test result. A lot higher r-squared value.
Significant Anova result at alpha =0.1.

1.5 Identify three (3) other variables other than Stock Index which can be used to
predict the stock price performance. Give a short explanation for this. 3pts

2. Decision analysis – 20 pts

A manufacturing concern has developed the following table concerning possible

expansion activity for the business. It shows the size of the facility they may consider
as well as the possible market condition in terms of demand for their products.

Market Condition
Facility Size Strong Fair Poor
Large 500,000 100,000 -310,000
Medium 400,000 120,000 -100,000
Small 200,000 100,000 -40,000
No facility 0 0 0

2.1 What is the best action plan for the company under the following:
a. Maximax; 1pt
b. Maximin; 1pt
c. Equally likely; 1pt
d. Realism with alpha at 0.3, 0.8. 2pts

Maximax: 0.25 for output; large facility expansion to maximize conditional value =500K
1pt
Maximin: 0.25 for output; no facility expansion to maximize conditional value =0. 1pt
Equally likely: 0.25 for output; medium facility to maximize value =138,600. 1pt
Realism at 0.3: 0.25 for output; medium facility to maximize value = 50,000. 1pt
Realism at 0.8: 0.25 for output: large facility to maximize value = 338,000. 1pt
 2.2 The company was able to determine probability of occurrence of the market
condition as follows: strong at 50%, fair at 30%, and poor at 20%. What is the
best decision for the company? 1pt

Under EMV, large facility to maximize EV=218,000.

a. What is the value of perfect information? How can the company make use
of this result? 2pts
Value of perfect information =68,000. Use – the amount they will be willing to pay to
purchase information that will lead to occurrence of specified state of nature, ie whether
market condition will be strong, fair or poor. 2pts

b. What is the opportunity loss? 1pt

Opportunity loss = 100,000. 1pt

c. What is the decision under criterion of rationality? 1.5pt

Under criterion of rationality, medium facility to maximize value =138,600. 1.5pts

d. What is the decision under maximum likelihood? 1.5pts

Highest probability =0.5. Highest payoff under this =500,000. Therefore, decision is for
large facility. 1.5pt
 2.3 Suppose the probabilities are changed as follows – strong is 30%, fair is 50%
and poor is 20%. Use decision trees to find the best solution for the company.
Compare with the result in 2.2. 3pts

1pt for 2 outputs – initial decision tree set up & final decision tree solution
Best solution is medium facility where EV highest =160,000. The EMV solution is for large facility
with EV highest =218,000.